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Comments

i have a question on how should candidate treat under-over hedging in an exam question. Say a contract size 5.39 rounding to 5 in previous Example 11 . Will student be expected to treat the remaining 0.39 under-hedging if the exam question did not ask?

If you have the time in the exam, then yes. However, it never carries more than 1 or 2 marks, and so if you are short of time just write that they could use forward contracts on the under/over hedge, without spending time on the calculations.

I can’t understand why we don’t add EXPIRED basis to the futures rate or deduct UNEXPIRED basis from the spot rate to arrive at the lock-in rate if the difference between two rates falls in 2 months time by 2/3 (on the transaction date).

However, it depends on whether the current spot rate is higher or whether the current futures price is higher.

Appreciate that the the two rates get closer together (they will be the same on the expiry date of the future) and therefore the ‘lock-in rate’ must be between the two. You add or subtract accordingly.

The contract amount will be given in the question just as in the earlier examples. The lock-in rate is applied to the contract amount (multiplied by the number of contracts, again calculated as in the previous examples).